As income drawdown approaches its 15th anniversary John Moret assesses whether it has met peoples' needs
It’s nearly fifteen years since the introduction of income drawdown in July 1995. Few financial products have caused more debate – with support for drawdown fluctuating as investment markets oscillate and interest rates rise or fall.
During this time we have also seen the overdue development of new types of annuity products such as ‘third way’ variable annuities and fixed term annuities as the legislators have relaxed their definition of what constitutes an annuity. We’ve also seen the growing use of ‘scheme pension’ as an alternative to ASP and more controversially the introduction of ‘accelerated’ drawdown schemes which some would argue push the boundaries of exploiting the pensions tax regime too far.
During 2009 it is likely that around £4 billion was invested in new drawdown plans out of a total of around £14 billion of funds that were vested – the balance going largely into annuities. It has been estimated that these maturing funds could double in the next three years. The main issues for most investors looking to take income are the point at which they annuitise and how much of their accumulated funds should be converted. There is also a growing uncertainty regarding the sustainability of the existing tax regime with the prospect of change after this year’s election.
We have recently undertaken a brief review of the experience of our SIPP investors that elected to utilise income drawdown for the first time in 2002 and are still taking income. At that time of course the legislation required individuals to take a minimum annual income of 35% of the maximum allowed – and, unlike today, it was not possible to take cash without taking some income. Of the 50 individuals who elected this option in 2002, nine were female and a surprisingly high number – twenty-four – were aged under 60 when first taking income, with only three aged over 65. Other salient facts were:
• The largest fund was over £1.8 million with the average fund size exceeding £440,000;
• 44 of the investors took some cash averaging just under £85,000. The average initial fund utilised for drawdown was just over £360,000
• There was a wide range of incomes taken with 15 taking the minimum income during the first three years, and 14 taking maximum income in at least one of the first three years with the average annual income taken being around 50% of the maximum permitted.
We looked at the position of these 50 investors at December 2009. At that point the average fund value was just under £400,000 – an average decrease in fund size of 10%. This figure was slightly skewed by three individual portfolios which had grown by over 100% although in two of the cases income was taken at above the minimum level. However, there were 21 other investors where the fund had grown in size even after taking income. There was only one fund which had fallen in value by over 50% – in this case maximum income had been taken in the first three years and the fund was only 41% of the original fund.
We also compared the single life annuity that could have been secured in December 2009 with the equivalent annuity that could have been bought in 2002. On average the annuity too had also increased – by 18% – with 24 of the investors showing an increase.
Clearly this is a very simplistic analysis using a very small sample. Death benefits have been ignored and we have not looked at the investment strategies employed. Nevertheless the results are sufficiently comforting to suggest that the income flexibility offered by drawdown is being used sensibly.
I am not suggesting that this means fears about the unsuitable sale of income drawdown are ill founded. However, the findings do suggest that there are many situations where over a period of years income drawdown can be a valuable alternative to annuity purchase. Increasingly I expect advisers to be utilising blended solutions of drawdown, conventional and alternative annuities with the proportions invested varying over time reflecting the clients’ changing needs and attitude to risk.
The quality and regularity of advice is going to continue to be crucial. There are three risks to be managed – inflation, longevity and the sequence of investment returns. The last is particularly important as the incidence of returns can have a big influence on the speed at which the fund will deplete.
Regardless of what legislative action is taken by the next government in this area, I am confident that this will be a marketplace of growing importance to advisers – and one where technology really can provide valuable assistance to advisers in formulating their recommendations and subsequent reviews.
John Moret is director of marketing at Suffolk Life
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